DAY BY DAY BASED ON FACTS IN HAND
Market action Monday showed signs of high conviction to sell relative to the conviction to buy.
LOOKING AT WORST-CASE SCENARIOS
While a long-term uptrend remains in place, our goal is to navigate between a point A and a point B that could be several years down the road. Given normal pullbacks and corrections will occur along the way, having a realistic expectation about volatility is key when trying to stay with an existing uptrend. When we see an unbalanced tape, as we did Monday, it is prudent to develop profit-protection strategies and bear-market contingencies.
MAXIMUM PAIN
Since the January 24 video looked at historical market performance walking forward at fixed intervals (one month, two months, three months, etc.) and given the lopsided tape during Monday’s stock market sell-off, it is logical to examine maximum one-year drawdowns in the 47 similar historical periods covered last week.
For clients, the key takeaways are:
Based on the the nine recent stock market signals, the average maximum closing drawdown from the date of the historical signals was 4.29%.
Since the present-day cases featured signal dates ranging between 11/29/2019 and 01/24/2020, hypothetical drawdowns in 2019-2020 must be calculated from the signal date.
If we assume the S&P 500 made a pullback or correction high on January 17, 2020 at a closing level of 3329, the average hypothetical drawdown in 2020 comes to 6.14%, based on the historical drawdowns, recent signal dates, and the recent S&P 500 high.
As of Monday’s close, the S&P had dropped 2.58% from the recent closing high. Therefore, based on the historical drawdowns following past signal dates, there is roughly a 28% chance the S&P 500 has already made a low. Conversely, there is roughly a 72% chance the market has further to fall. If we look at the maximum drawdowns immediately following the historical signal dates (MAX DRAW FROM SIGNAL DATE column), there is a 45% probability the market has already made a low.
PROFIT-PROTECTION PLANS
In terms of protecting profits, it is helpful to understand if the market experienced the average historical drawdown, the S&P 500 would hypothetically drop to 3125 and reach that level on March 23, 2020. If the market experienced the median historical drawdown, the S&P 500 would hypothetically drop to 3132 and reach that level on February 14, 2020. The table above should be viewed in the context of the weight of the evidence, including a rare bullish DeMark signal covered in November 2019.
RESPECTING A WIDE RANGE OF OUTCOMES
The exercise above helps us better understand a wide range of outcomes, from the market made a low Monday to the market could reasonably fall for several more weeks. The data above will be used to develop prudent bird-strike/profit-protection contingency plans to complement the signals from the CCM Market Model.
NO ASSUMPTIONS, NO PREDICTIONS
Walking forward, our concerns and profit-protection strategies will be based on what is actually happening. If the conviction of buyers relative to the conviction of sellers returns to a more balanced state, then the probability of taking profit-protection steps will drop. Conversely, if the market begins to check off additional lopsided-conviction boxes in the coming days and weeks, our contingency plans will be adjusted accordingly.
As always, the market will decide. Our job is to monitor the incoming data with an open mind. The maximum drawdown study above helps us monitor new information with a data-based respect for a wide range of outcomes over the next one to three months.